A minor downgrade led to a market sell-off... SPECIAL OPPORTUNITIES [The Oxford Club Special Opportunities]( Beware of This Terrifying Butterfly Matt Benjamin, Senior Markets Expert, The Oxford Club [Matt Benajmin] Perhaps you're familiar with the butterfly effect. For those of you who are a bit hazy on this term, it originated in an obscure branch of mathematics called chaos theory. And it refers to the fact that in a system with many sensitive interdependencies, a tiny change in one place can lead to major repercussions elsewhere. The name of the effect comes from the idea that a butterfly flapping its wings in Brazil could eventually set off a tornado in Texas. As the metaphor suggests, this can create a scary state of affairs. Well, some recent events suggest we may have achieved just that state in the financial markets. Minor Downgrade to Huge Sell-Off Here's the story in a nutshell. On March 26, a Wells Fargo (NYSE: WFC) analyst downgraded his outlooks for ViacomCBS (Nasdaq: VIAC) and Discovery Inc. (Nasdaq: DISCA). His reasoning for the downgrades was specific to the industry: Those two media companies will face increasingly tough competition in the streaming space from behemoths such as The Walt Disney Company (NYSE: DIS) and Amazon (Nasdaq: AMZN). It seems reasonable. And, predictably, the downgrade triggered sharp sell-offs in those stocks (they were already trending downward). Both of the downgraded companies tumbled around 27% last Friday. Unless your portfolio was overweight in those stocks, there was nothing much to worry about... Except for the terrifying butterfly effect. A large hedge fund called Archegos Capital Management had built up a significant position in both Viacom and Discovery. The fund, which had borrowed heavily from its brokers to buy stocks, suddenly saw these lenders concerned about the loans. The lenders demanded cash to cover any potential losses stemming from the Viacom drop in particular (those demands are called margin calls). To cover those margin calls, Archegos liquidated some $20 billion of its stock portfolios on March 26. And potential losses at Archegos also did real damage to the stocks of Nomura Holdings (NYSE: NMR), Japan's largest investment bank, and Swiss giant Credit Suisse (NYSE: CS) - both of which had lent money to Archegos. The two banks are now warning of major losses this year. Finally, all the mass selling and warnings of losses triggered a sell-off in Asia over last weekend, which spread to U.S. markets Monday morning, as investors panicked about fears of contagion. To be fair, the sell-off in U.S. markets was not steep, and stocks rebounded in afternoon trading. Call it more of a thunderstorm in Texas than a tornado. But the butterfly effect was there for all to see. An analyst's downgrade that was focused solely on the streaming industry resulted in major market sell-offs around the globe. So Who's to Blame? So what's brought us to this delicate state where minor decisions one place can lead to major effects elsewhere? It's liquidity. There's just too much of it. With central banks printing money hand over fist, too many market participants are borrowing enormous amounts of it to invest. These investors become overleveraged. And when something goes wrong, things can go from bad to terrible in an instant. In addition, all that money sloshing around is driving stock valuations through the roof. According to Gavekal Research, due to an abundance of central-bank-generated liquidity, nasty local liquidity squeezes are popping up everywhere. "Liquidity is a coward," according to Gavekal. "As soon as a fight starts, he disappears." This will continue to be the case until central banks move away from zero interest rates and stock valuations come back to earth. So cautious investors will want to be prudent in their own borrowing and look for stocks with more reasonable price tags, namely value stocks. Investors, proceed accordingly! On an unrelated (or maybe slightly related) note, the Ever Given - the 400-meter cargo ship that ran aground in the Suez Canal on March 23 and created a massive global traffic jam of hundreds of ships, halting billions of dollars in trade - is finally moving again. Maybe, just maybe, this will be the kind of butterfly that creates a few sunny days in markets instead of a tornado... Enjoy your weekend and stay safe, Matt P.S. Are you interested in great opportunities in value stocks? How about the tiny $4 tech stock with the technology that could replace smartphones? Chief Investment Strategist Alexander Green has just the right service for you. 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